Chicago Booth Magazine

The Mentor: In his own words, Eugene Fama talks about the power of markets
and friendship

Interviewed by Patricia Houlihan (Photo by Michael Girard)

Every year I ask the best PhD
students in my class to be research
and teaching assistants. David Booth
was the best of his group.

He went through the academic part of the program with flying colors but then came
to me and said, “I don’t think I want to do research and teaching. I want to go out
into the world of business.” I said, “Fine, there are a lot of rich and famous people who
don’t have PhDs from the University of Chicago.”

So I called up Mac [John A. McQuown] who was head of investments at Wells Fargo
and had come to all of the Center for Research in Security Prices (CRSP) conferences,
and I said I had a very good student he might want to hire. So David went to work for
Mac. In 1980 or 1981, David came back to me and said he was thinking of starting his
company, Dimensional Fund Advisors.

The idea was that people to whom he was selling institutional products weren’t getting
exposed to small stocks, and he thought products that gave them that exposure
would sell well. I told him we just had a PhD thesis here that studied the returns on
small stocks, and it said they seemed to be somewhat higher than what can be explained
by the asset pricing model we had at that time. What a way to kick the game off.

David also asked me to join him and Mac on his company’s management
board.
The boards of directors of the funds have always been Chicago people, either
graduates or current professors, and the company is very Chicago oriented. The general
philosophy is that prices work, and you want to give people a way to develop risk
profiles that they find acceptable. But basically no stock picking.

Then in 1992, Ken French and I developed material on the returns on stocks with
high book-to-market ratios. I told David about it, and he said, I think I have a client
who would be interested in that. He brought this fellow to my office and—the paper
hadn’t even been written yet—he just looked at my computer screen and I showed him
the results. That launched Dimensional’s value products, which subsequently became
big portfolios in the package.

Now they have value products everywhere in the world and they have more general
kinds of stock portfolios. But all of it is based on the proposition that you want
to give investors a way to get exposure to various dimensions of risk that seem to be
compensated in long-term returns, with a bottom-line presumption that everything
is priced correctly and you get returns in the long term appropriate to the risks that
you take. Asset allocation rather than stock picking is the motivation behind it, so it’s
very “Chicago efficient markets.”

I’m nominally the director of research of the company, but as far as I can tell, I’ve never
directed anything. Rex [Sinquefield, ’72], David, Ken French, and I would just sit down
and talk and talk. Rex retired and there’s now a fellow from Cal Tech, Eduardo Repetto,
who’s the chief investment officer. The four of us develop the products, raise questions
about the existing products, and monitor the process. The time I spend with them is
much less time than I spend on research, and research is, in the end, what generated
the big stuff that gave them these products to begin with.

Dimensional opened an office in Newport Beach and eventually moved up to Santa
Monica, around the time I was starting to visit UCLA. We became much more friendly
in that period of time—David and Suzanne are great friends of ours.

You know, you have this theory that you believe is going to work, but to actually
see someone base a company on it and succeed has been fun. In the beginning,
it wasn’t clear if the firm would survive or not because, although small stocks on average
have generated higher returns than big stocks, during the first few years we were in
business, it went the other way. That’s not usually very good for an investment company
just coming on line. Even with the recent crash, we’re at the top of U.S. money managers,
in terms of funds under management. That’s not so bad.

I’ve always had a philosophy here at the university that we want the business
school—the faculty—to be more than the sum of its parts. That requires an openness
and an acceptance among faculty so that even if you disagree with others extremely,
you accept that they believe in what they’re doing, and they’re doing work that we
want to have here. Dick Thaler and I are great friends even though we’re on opposite
ends of the spectrum.

It’s similar at Dimensional. We’ve never had harsh words among us—Ken,
Rex, David, and me. This is part of the success of the company. David and Rex are
not your typical corporate executives. They’re very humble people. They listen and
think they have something to learn from almost everybody. I think that’s a quality to
have in a business leader—and I don’t think a lot of business leaders have it. If they
listen and disagree, they say we’ll disagree with you. Usually I’ll say OK, but on other
things, I’ll dig my heels in and say, I don’t think you’re right on this one. In the end,
no one cares, and in that sense, it’s very much like the best academic discussion.
Interviewed by Patricia Houlihan